K-Bro Linen Inc. (TSX: KBL, OTC: KBRLF) is one of the select companies that fulfills nearly all of our demanding criteria for what makes a Dividend Champion. Among the firm’s key attributes in this regard are steadily growing profits and dividends, strong cash flow, high returns on capital, and low debt levels.

K-Bro is the largest owner and operator of laundry processing facilities in Canada and provides a full range of linen processing, management and distribution services to healthcare institutions and hotels.

Among K-Bro’s biggest clients are the Vancouver Coastal Health Authority, Health Shared Services Saskatchewan, Alberta Health Services, and St. Michael’s Hospital in Toronto. The firm’s services are engaged under long-term contracts that typically range from seven to 10 years.

Large-Scale Expansion

When we first added K-Bro to our Dividend Champions Portfolio back in September 2015, the company had just embarked upon an ambitious capital program, with plans to invest C$121 million through 2018 to develop new processing facilities.

To put these numbers in context, the firm previously spent C$80 million to develop new facilities over the 10-year period that ended in 2014. So K-Bro has greatly accelerated its spending.

The major milestones under this new program include the opening of the C$36 million Regina plant in late 2015 and the start of services at its healthcare facilities in Saskatchewan under a 10-year contract.

In addition, K-Bro is building new facilities in Toronto and Vancouver, which have total estimated costs of C$85 million and are slated for completion by mid-2018.

Management believes the new facilities will lower operating costs and help win new contracts.

However, there is a near-term downside to these long-term investments. The cost and disruption associated with bringing new facilities on line can weigh on profit margins, as shown in the accompanying graph.

Management has already warned that the transition to the new Toronto plant in early 2017 and the Vancouver plant in mid-2018 will temporarily reduce profit margins. Therefore, we expect profit growth will remain muted until the second half of 2018.

But these investments position K-Bro for excellent long-term growth, while the short-term headwinds associated with them give value-oriented investors an opportunity to pick up shares at a more reasonable price.

Why Remain Invested?

Despite these near-term challenges, K-Bro has achieved a remarkably steady performance over the years, thanks to long-term contracts and substantial exposure to the recession-resistant healthcare sector. Conservative business expansion and financing practices complete the picture of an unexciting, but stable business.

After K-Bro completes its latest capital plan in 2018, we expect profit growth to accelerate as the new facilities bring in new customers, while margins expand as greater scale reduces costs.

Canada’s linen service industry remains fragmented, which gives K-Bro an opportunity to achieve further growth via consolidation. The firm, itself, could also become an acquisition target, given its more reasonable valuation of late and the low Canadian dollar.

Although K-Bro is in the midst of a major spending plan, its dividend remains relatively safe. The firm boasts a solid balance sheet, generates ample cash flow, and has a low payout ratio. However, we do not expect any growth in the payout until after K-Bro completes its current investment cycle in 2018.

A Reasonable Value

Excellent companies seldom offer investors a chance to buy shares at a reasonable price, but K-Bro now trades at an attractive valuation of 11 times its forward EV/EBITDA ratio (enterprise value to earnings before interest, taxation, depreciation and amortization), which is a lower mutiple than its U.S. peers. K-Bro’s stock yields 2.9%, and we estimate its fair value at C$46, or US$34.